SEC Edges Toward a Structural Overhaul for Bitcoin and Ethereum ETFs
As the US Securities and Exchange Commission (SEC) navigates the evolving landscape of cryptocurrency investments, a significant shift is on the horizon for Bitcoin and Ethereum exchange-traded funds (ETFs). The SEC is contemplating a pivotal transformation in the operational framework of spot-Bitcoin and Ethereum ETFs. This comes as five Cboe BZX-listed ETFs have simultaneously proposed a switch from their current cash-only creation and redemption model to in-kind mechanisms, a method long utilized by commodity and equity ETFs.
Recent Filings Signal a New Era for Crypto ETFs
On July 22, a series of filings were submitted, covering the ARK 21Shares Bitcoin ETF and the 21Shares Core Ethereum ETF, along with WisdomTree’s Bitcoin Fund and Fidelity’s Wise Origin Bitcoin and Ethereum Funds. Each amendment seeks to replace previous language in approval orders from early 2024, which restricted the ETFs to cash transactions. The new language introduces the possibility of “cash or in-kind transactions,” complete with detailed workflows for direct transfers of Bitcoin or Ether between the trust’s custodian and authorized participants.
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Expert Insights on the Proposed Changes
Bloomberg ETF analyst James Seyffart, who first identified this coordinated effort, expressed optimism in a social media post, highlighting the potential benefits of in-kind creation and redemption for Bitcoin and Ethereum ETFs. He clarified that these changes are designed for Authorized Participants, such as large Wall Street firms and market makers, rather than retail investors. Seyffart noted that while the majority of consumers may not notice immediate differences, the shift will enhance the overall efficiency of crypto ETFs, aligning them with other exchange-traded products (ETPs).
Understanding the Importance of In-Kind Transactions
The existing cash-based model for spot Bitcoin ETPs, implemented when they were approved in January 2024, requires an authorized participant (AP) to deliver dollars to the fund, which then purchases the cryptocurrency on the spot market. This process, while addressing SEC concerns about custody and settlement risks, has introduced certain frictions. The trust must engage in market trades, and order flow can lead to discrepancies between net asset value and share price during periods of thin liquidity.
The Benefits of In-Kind Processing
In contrast, in-kind processing allows authorized participants to manage trades directly. When creating shares, the AP transfers Bitcoin or Ether directly to the fund’s cold wallet. During redemptions, the AP receives coins instead of cash. This structure, common in the ETF ecosystem, offers advantages such as tighter spreads, reduced primary-market imbalances, and significant tax benefits. The SEC acknowledges that ETFs can be more tax-efficient due to the in-kind nature of share redemptions.
Existing commodity trusts utilizing in-kind redemptions provide a regulatory template for crypto issuers. For instance, SPDR Gold Shares permits an authorized participant to exchange a basket of 100,000 shares for physical bullion. By adopting similar language, Bitcoin and Ether trusts are seeking equality with existing commodity ETPs.
Market Implications and Future Prospects
The operational dynamics of the primary market are also evolving as volumes grow. Since the launch of eleven spot Bitcoin ETFs in 2024, nearly $55 billion in cumulative net inflows has been recorded. Market-making desks face the challenge of sourcing billions in cash each settlement day and unwinding crypto exposure post-purchase. Allowing in-kind transactions enables desks to continuously source or hedge Bitcoin and Ether, delivering assets directly into the trust’s wallet, streamlining the process and enhancing market efficiency.
As of the latest updates, Bitcoin is trading at $118,769. The transition to in-kind transactions represents a significant step forward in the maturation of the cryptocurrency ETF market, promising to bring these products in line with their traditional counterparts while potentially paving the way for future retail investor involvement.
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